Opinion
10703-19
06-16-2021
CFM Insurance, Inc., Petitioner v. Commissioner of Internal Revenue, Respondent
ORDER
Mark V. Holmes, Judge.
This microcaptive-insurance case was assigned to this division of the Court. In it CFM Insurance challenges the Commissioner's determination of deficiencies and penalties. The Commissioner has moved for partial summary judgment on part of one issue -- proof that he complied with the penalty-approval requirements of IRC section 6751(b)(1).
The usual summary-judgment rules apply: We may grant summary judgment only when there's no genuine dispute of material fact and a decision may be rendered as a matter of law. Rule 121(b); see Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992). We view the factual materials and the inferences that can be drawn from them in the light most favorable to the nonmoving party. Id.
Section 6751(b)(1) prevents the Commissioner from assessing any penalty unless the initial determination to impose it was "personally approved (in writing) by the immediate supervisor of the individual making such determination . . . ." Sec. 6751(b)(1); see Graev v. Commissioner, 149 T.C. 485, 493 (2017) (citing Chai v. Commissioner, 851 F.3d 190, 221 (2d Cir. 2017), aff'g in part, rev'g in part 109 T.C.M. (CCH) 1206 (2015)), supplementing and overruling in part 147 T.C. 460 (2016). Written approval can take many forms, Palmolive Building Investors, LLC v. Commissioner, 152 T.C. 75, 85-86 (2019), but it must be given before the Commissioner first formally notifies the taxpayer that he has proposed a penalty, see Beland v. Commissioner, 156 T.C., 2021 U.S. Tax Ct. LEXIS 8*, at *5 (citing Clay v. Commissioner, 152 T.C. 223, 249 (2019), aff'd 990 F.3d 1296 (11th Cir. 2021)). The Commissioner asserts a 20% accuracy-related penalty under section 6662(a) for negligence or disregard of rules or regulations for each of the years at issue. (He asserts in the alternative that CFM owes the penalty for substantial understatement.) On this motion, we must first decide what the undisputed facts show about when he formally notified CFM of his decision to assert these penalties, and then we look backwards to see if that decision had previously been approved in writing by the immediate supervisor of the individual making the decision. If the evidence we have leaves no genuine dispute that it was approved, we will grant the Commissioner's motion.
So when did CFM first receive formal notification? There are a couple of possibilities here. The first was when it received a Letter 950 -- better known as a "30-day letter," see Internal Revenue Manual (IRM) pt. 4.10.8.12.1(8)(b) (Mar. 25, 2021) -- that informed it of the Commissioner's proposed adjustments and notified it of its right to request within thirty days a conference with the IRS Office of Appeals. A supervisory Revenue Agent by the name of Ted Spencer signed this letter, dated on August 6, 2018. The letter stated that enclosed with it was a Form 4549-A, Income Tax Examination Changes ("Examination Report" or "RAR"). There can be no genuine dispute that this Examination Report was signed by Revenue Agent Van Nguyen and dated July 25, 2018. The other enclosures that RA Spencer's letter listed were a Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment ("Agreement Form," which CFM could have signed and returned if it had not wanted to challenge the proposed adjustments, see IRM pt. 4.32.4.5(6) (Dec. 12, 2013)); a Form 12203, Request for Appeals Review; Publication 3498, which describes the IRS's examination process; and an envelope.
RA Nguyen's Examination Report listed on Line 17, Penalties/Code Sections, "Accuracy-IRC 6662 (40%)" for each year at issue. It also listed on Line 19, "Summary of Taxes, Penalties and Interest" a penalty in the amount of 40% of the tax due for each year. The Agreement Form also showed a penalty equal to 40% of the tax due for each year, with the label "IRC 6662."
So there is no genuine dispute that RA Nguyen had proposed a 40% penalty and his supervisor had approved it in writing. The Commissioner's problem is that the 40% penalty never made it into the notice of deficiency -- the notice asserts only a 20% penalty.
Where's the supervisory approval of that penalty?
Our caselaw tells us to focus on the formal notice that a taxpayer gets. Did any of these documents give formal notice to CFM of the 20% penalty? Ordinarily, an Examination Report and 30-day letter is sufficient to clear the 6751(b)(1) hurdle. See, e.g., Thoma v. Commissioner, 119 T.C.M. (CCH) 1447, 1472 n.34 (2020). But in this case, there was no mention of a 20% penalty's being asserted in the 30-day letter or any of the documents listed as enclosures; the Examination Report and Agreement Form both mention 40% penalties for each year pursuant to section 6662, but section 6662 allows for 40% penalties in only three instances: when an underpayment is due to a "gross misvaluation misstatement," § 6662(h), a "nondisclosed noneconomic substance transaction," § 6662(i), or an "undisclosed foreign financial asset understatement," § 6662(j). The 20% penalties under section 6662(b)(1) for negligence or disregard of rules or regulations (or substantial understatement) are distinct from each of these 40% penalties and must receive separate supervisory approval to cross over the section 6751(b) threshold. See Sells v. Commissioner, 121 T.C.M. (CCH) 1072 (2021), T.C. Memo. 2021-12, at *11. "Formal notice" requires that the penalty be described with sufficient particularity so a taxpayer knows what he is accused of. See Legg v. Commissioner, 145 T.C. 344, 350 (2015) ("Congress enacted section 6751(b) to ensure that taxpayers understood the penalties that the IRS imposed upon them"). An Examination Report and 30-day letter that mention only a 40% penalty do not provide notice of a 20% penalty. See Oropeza v. Commissioner, 120 T.C.M. (CCH) 71, 72 (2020). As a matter of law, then, neither the 30-day letter nor any of the documents listed as enclosures provided CFM with formal notice of the 20% penalties under section 6662(b)(1).
The Commissioner's argument looks like a loser so far.
Here's where things get strange. RA Spencer's form letter doesn't mention that smaller penalty, and none of the documents that his letter says are enclosed with it mention it either. But there was another document stuffed in the envelope with RA Spencer's letter and its enclosures -- a Form 886-A, Explanation of Items. As its name suggests, this form is used to explain adjustments made in an Examination Report, and it's IRS standard practice for a revenue agent to attach it to the Examination Report. See IRM pt. 4.10.10.2(2) (Nov. 30, 2017).
But the Form 886-A that CFM got was not standard. It first lists as an issue "[w]hether Taxpayer is liable for the [a]ccuracy[-]related penalty under IRC § 6662(a) and (b) for the taxable years 2012, 2013, 2014, and 2015 in an amount that is 40% of the amount of the underpayment." But it then asserts in its conclusion that "the Taxpayer is subject to the penalty under IRC §§ 6662(b)(1) and (2) for negligence, disregard of rules and regulations, and substantial understatement with the primary position being IRC [§] 6662(b)(1) and the secondary position IRC § 6662(b)(2)." That is the only mention of the 20% penalty in the package that CFM got.
That document correctly identifies the reasons for and subsections under which the penalties were being asserted, but incorrectly identifies the amount. And that's not the only irregularity. An initial glance reveals that the text of the Form is shrunk so that each page only takes up about half the area of the paper it's printed on. Closer inspection shows that it includes errors (e.g., the phrase "Error! Bookmark not defined" appears several times in the Form's table of contents) and what appear to be highlights and comments made by someone reviewing the report using a "track changes" function. So, is this "formal notice?" The parties disagree. CFM argues that the Form 886-A was merely a "draft", and therefore embodied nothing more than the IRS's internal deliberative process. Cf. Tribune Media Co. v. Commissioner, 119 T.C.M. (CCH) 1006, 1010 (2020). We might justly say that CFM is the nonmovant and we have to draw inferences in its favor -- and it does seem that the Form 886-A looks like a draft that somehow got into the mailing.
The best formulation of the Commissioner's argument is therefore that, even if this Form 886-A was a draft, it was still a formal communication just because the IRS included it with the 30-day letter. Let us assume for argument's sake that this Form 886-A provided "formal notice." That's not enough for the Commissioner to win. We have to ask some more questions: Was it approved by the supervisor of the person who prepared it? And who, for that matter, prepared it?
The form itself doesn't have any names on it. We have the Examining Officer's Activity Record, which shows that three separate revenue agents worked on it over the course of four years: RA J. Freeman from August 2014 to November 2017, an unnamed RA from November 2017 to January 2018, and RA Nguyen from January 2018 to the examination's completion. The parties agree that RA Spencer, who signed the 30-day letter, was RA Nguyen's immediate supervisor. There is nothing in the record on this motion to show who supervised RA Freeman or the secret agent man. We also can't tell from the Activity Record when the decision was made to impose the 20% penalties on CFM or who made that decision. But we can tell that RA Freeman had begun working on the Form 886-A by October 2015, and it was "[a]lmost as complete as it will be" by December 2017. And even if one assumes that RA Nguyen was the one who made the "initial determination" to impose the penalty, the evidence does not definitively show that RA Spencer approved that determination in writing. It is true that RA Spencer signed the 30-day letter and that the Form 886-A was sent to CFM with that letter. But we must infer on this motion that the Form 886-A was in an incomplete state. That it was not mentioned as an enclosure on the 30-day letter also supports as a plausible inference at this point that RA Spencer never saw the Form before signing the letter.
"With every move he makes, another chance he takes" -- presumably of not being able to identify his immediate supervisor. See Johnny Rivers, Secret Agent Man, on And I Know You Wanna Dance (Imperial Records 1966).
This means that the Commissioner cannot rely solely on the 30-day letter packet to prevail in his motion for partial summary judgment.
That's not quite the end of the matter. Let us assume that the Form 886-A did not provide formal notice. When was the next opportunity for formal notice? After receiving the 30-day letter and the accompanying documents, CFM's attorney Kacie Dillon spoke with RA Nguyen and RA Spencer by phone. On that call, Dillon asked why the Commissioner was seeking a 40% penalty instead of a 20% one. According to the Activity Record, RA Spencer explained to Dillon why a 40% penalty had been asserted. According to Dillon, RA Spencer told her "that most of the adjustments proposed were done at the direction of IRS Office of Chief Counsel, and [he] did not know why a 40% penalty was proposed in this case." There is evidence that RA Nguyen and IRS Counsel Michael Harrel traded emails in the following days, and that RA Nguyen called Dillon on September 24, 2018, to tell her that the 40% penalty was incorrect and that the penalty should have been 20%. That same day he faxed her a revised Examination Report and Agreement Form, as well as Page 2 of the original Form 886-A. We do conclude that there is no genuine dispute that by that date CFM knew which penalties the Commissioner proposed and that it had the opportunity to protest those proposals. See Clay v. Commissioner, 152 T.C. 223, 249 (2019). We therefore hold that there is no genuine dispute that CFM had "formal notice" no later than September 24, 2018.
Was there written supervisory approval on or before that date? Here the record shows no dispute that there was a Fraud Development Lead Sheet dated November 20, 2018. This is a form that RA Nguyen completed, and it does state "20% accuracy related penalty asserted as counsel advices" [sic], but a box indicating the "[d]ate of discussion with manager" is left blank. And this form is dated nearly two months after CFM had received formal notice of the penalties. We also have a redacted email conversation between RA Nguyen and Harrel from September 20 and 21, 2018. But because the Commissioner has asserted attorney-client privilege, we don't know the contents of that conversation. CFM reasonably infers that it was Harrel, not RA Nguyen, who made the initial determination to impose 20% penalties. If true, it would be Harrel's supervisor who would have had to give written approval. But the record doesn't include any such approval --and we don't even know who Harrel's supervisor was.
We cannot hold that there is no genuine dispute as to who made the initial determination to assert 20% penalties, whether such determination received written supervisory approval, or when such approval might have been given. It is therefore
ORDERED that the Commissioner's September 16, 2020, motion for partial summary judgment is DENIED.